Shareholders, who invest large amount of money in the companies, generally, expect to get satisfactory income on their funds as they require increasing the value of their investments as much as possible. This growth is often determined by payment of dividend and or capital gains by raising the market value of the share price. Shareholders ' wealth is maximized when a decision produce net present value. The net present value is the difference between present value of the cash inflows of a project and its initial costs. A decision that has a positive net present value increases wealth for shareholders and negative net present value decrease the share price. For that reason, only projects with positive net present value should be accepted. For instance, suppose a business invests $ 20,000 in a project that generates net cash flow $ 5,000 each year for five years. If the firm requires 5% return on its ca...
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...YZ. If the seller knows the one of the manager in the company and has heard that the company is facing undisclosed financial problems, then the seller has asymmetric information. The capital structure decision, taken by managers, may then work as an indication to communicate insider information to external investors. Management often utilise the information to increase their own wealth, whereas, outside investors do not have access to that information. Managers learn how and when to make maximum profits from control of the firms’ operations which may establish them and pursue self-serving actions at the expenses of shareholders. Due to information asymmetry, shareholders do not have adequate information to assess if managers have satisfied their contractual duties.
It is shown, that the informational asymmetry can account for a substantially lower leverage ratio.
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